Friday, August 13, 2010

Lump of labour fallacy fallacies.

The lump of labour fallacy is often cited in response to the idea that shortening the working week alleviates unemployment. The latter idea, of course, being that if less work is done by existing employees, that will leave work that can be done by some of the unemployed.

A fair amount of nonsense has been published on this whole subject. I’ll set out the flaw in the shorter working week idea and then deal with various bits of nonsense that surround the subject. Plus I’ll argue that the phrase “lump of labour” is a poor description of the flaw in shortening the working week.

Shortening the working week is actually just ONE of numerous methods of REDUCING LABOUR SUPPLY. That is, a similar “employment creation” argument can be erected in relation to ANY method of reducing labour supply. For example it is sometimes argued that early retirement or delayed entry into the labour market for youths will leave unfilled vacancies which can allegedly be filled by the unemployed. And a nice example of a labour supply reduction scheme from history was the idea advocated by King James I of England (1566 –1625), namely that unemployment could be reduced by shipping the unemployed off to Newfoundland and Virginia. He thought that would reduce the number of unemployed in England.

In view of the variety of labour supply reduction schemes, I’ll refer henceforth to “labour supply reduction” (LSR) rather than to “shortening the working week”, for the most part.

Clearly a significant proportion of economists cannot see the flaw in LSR because the French actually implemented a shortened working week a few years ago because they thought this would reduce unemployment.

The flaw in the argument is actually closely related to the fundamental reason why inflation arises near full employment, and for the following reasons.

Given significantly higher unemployment than normal, it is relatively easy for employers to find the skills they want: the more unemployed there are, the better the chance of finding a specific skill. However, given rising demand and falling unemployment, it becomes progressively more difficult for employers to find skills.

Now when demand for a skill exceeds supply, the wage for that skill tends to rise. And that does not matter too much so long as only a few skills are involved. But given falling unemployment, skill shortages get progressively worse until the point comes where the wage for so many skills or professions is being forced upwards that general inflation ensues. Or the labour market exacerbates whatever inflation already exists.

Now suppose employment in an economy is at a level such that a further increase in demand and employment will cause excess inflation. That level is sometimes called NAIRU (Non Acceleration Inflation Rate of Unemployment) and sometimes called the “Natural Rate” of unemployment. I’ll use the acronym NAIRU for want of any better (rather than because I agree with every detail of the NAIRU theory on the strictly correct definition of the phrase).

Suppose also that employees are forced to work fewer hours per week. That will result, as the advocates of the shorter working week claim, in work being left undone. Employers will then attempt to locate the skills needed to get that work done.

But wait a minute – remember we have assumed that the economy is at NAIRU: the employment level at which locating skills is so difficult that inflation will ensue if employers try to attract those skills by bumping up the pay for said skills!

TO SUMMARISE, LSR CURES FOR UNEMPLOYMENT DO NOT WORK FOR EXACTLY THE SAME REASON AS THERE IS AN UPPER LIMIT TO EMPLOYMENT LEVELS SET BY INFLALTION.

Of course, the assumption that an economy is at NAIRU is an artificial assumption. But relaxing this assumption does not get the LSR argument anywhere. That is, if unemployment is well above NAIRU, then LSR schemes WILL WORK. Reason is that the above skill shortage point does not apply. But in this situation, employment can perfectly well be raised by increasing demand! That is, there is NO NEED for LSR schemes!

In short there is NO LOGICAL NICHE for LSR schemes.

Labour supply reduction fallacies.

Now for some of the nonsense that surrounds this whole LSR subject.

1. The Wiki article on lump of labour claims that the reason employers may not hire extra workers on the implementation of an LSR scheme is “administrative cost to hiring more workers”. Well, that is a bit vague: there are “administrative costs” involved in doing almost anything.

The Wiki article lacks an explanation as to WHY administrative costs are prohibitively high in some situations (i.e. at NAIRU). The reason, as explained above, is that at low unemployment levels it is difficult to locate skills.

2. Bizarrely, Keynes put in a good word for shorter hours. He said “It becomes necessary to encourage wise consumption and discourage saving, and to absorb some part of the unwanted surplus by increased leisure, more holidays (which are a wonderfully good way of getting rid of money) and shorter hours’’ (p. 323). (“The Long-Term Problem of Full Employment’’, 1943, p. 323). That sentence is complete nonsense.

Keynes is clearly dealing with the paradox of thrift here, that is the fact that if the private sector saves money excessively (rather than spend it), unemployment ensues. Of course, FORCING people to go on holiday and spend money is a solution of sorts. But it’s a daft solution. The private sector only net saves when it thinks it has an inadequate stock of savings (a statement which is so obvious that it shouldn’t need making).

Far better than forcing people to go on holiday is to provide them with the level of savings they want. People can then make up their own minds as to how to split their time between work and leisure.

3. Advocates of shorter working hours often point to various beneficial effects: increased productivity, less stress, the environmental benefits of human beings consuming less. These arguments may well be strong enough to warrant shorter hours. But they have nothing to do with be basic theoretical flaw in LSR set out above.

In other words, there are several possible justifications for shorter hours, but reduced unemployment is not one of them.

4. It is often claimed by opponents of LSR that LSR advocates claim there is a fixed amount of work to be done, hence, for example fewer hours for one lot of people means others can work extra hours or find work. (e.g. see Wiki, point No 1.)

That “fixed amount of work” point is a dangerous point to make because it invites the obvious retort, namely that the total amount of work is NOT fixed in that economies EXPAND most of the time (and occasionally contract).

Samuelson actually attacks the above “fixed amount of work” idea here (p.1) and for precisely the above reason. Samuelson did not seem to realise that he is not attacking a fundamental weakness in LSR, but rather a poor description of the weakness.

In short, the phrase “lump of labour” is not a good description of the basic flaw in LSR.

The real flaw in LSR does not have much to do with “lumps” of anything or “fixed amounts of work”. The real weakness is the assumption that the “skills to vacancy matching process” by some unexplained magic, becomes more efficient just because labour supply is artificially constrained. That assumption is of course nonsense. Perhaps the flaw in LSR should be called the “labour market efficiency flaw”.